You've got to hand it to the Fed. It sure does a good job of keeping the markets on their toes!
The Fed may not have caused too much action on the charts with yesterday's FOMC statement, but it caught more than a handful of traders off guard with what it said. Its decision to keep monetary policy unchanged was pretty much expected. What came as a surprise was how pessimistic it sounded. What's gotten into the Fed?!
Blaming the weather
Well, believe it or not, it blames the weather for its glum mood. The central bank says that the economy hit a road bump in recent months mainly because of "weather-related disruptions." I know how rainy days can bring a person down, but I personally find it odd how the Fed can give this reason in January, considering it never blamed Hurricane Sandy in December.
In any case, the Fed decided that it'll keep buying securities at a rate of $85 billion a month because it doesn't think things will get much better in the near future. In fact, the FOMC said that it still sees downside risks ahead. In other words, "We ain't out of the storm yet, folks!"
Fed takes its cue from economic data
One of the things that I noted from this FOMC statement was how the Fed made no mention of plans of an early withdrawal of its stimulus program. To be honest, I'm not so surprised. After all, just last month, the Fed announced that it'll be basing its decisions on economic factors such as employment and inflation. And so far, they seem to be calling for more easing, if anything.
The unemployment rate is still at an elevated level (7.8%) and is hanging well above the Fed's target of 6.5%. Meanwhile, inflation has stayed under the central bank's 2.5% threshold and has generally been running below expectations, clocking in at 1.7% in December.
What these two factors suggest is that the Fed will likely continue with its current policy of low rates and open-ended bond buying.
New face, same feathers
I was also quite interested to see that Esther George, a known hawk, replaced Jeffrey Lacker in being the committee's lone dissenter. Now that Lacker is no longer a voting member, George has taken up the banner for the anti-QE camp.
She claims that if the Fed keeps easing, it could bring in economic and financial imbalances and ultimately lead to higher inflation expectations.
Disappointing GDP supports Fed's cautiousness
Yesterday, the U.S. advance GDP report for Q4 2012 was also released. It was, to say the least, a major shocker as it showed that the economy contracted 0.1% (versus the forecasted growth of 1.1%). It was the first decline reported in more than 3 years.
According to the report, the contraction was primarily caused by an inventory buildup, a drop in net exports, and a 22% reduction in military defense spending. But of course, there were also a few bright spots. Consumer spending and durable goods purchases, for example, both improved. Consumer spending grew 2.2% while durable goods climbed a whopping 13.9%.
At the end of the day, as disappointing as it was to see the economy shrink in Q4, it's unlikely that we'll see the U.S. fall into a technical recession this quarter. Consumer spending is on the rise and it is improbable that we'll see the drag in inventory mirrored in Q1 2013.
How did the Greenback react?
As you can see, the day was ultimately dollar bearish, but surprisingly, the weak GDP report had a bigger impact than FOMC statement. This suggests that yesterday's statement gives the market no reason to stop selling the Greenback, as we're not in danger of losing "easy money" from the Fed any time soon.
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